Group Affiliation and Default Prediction

Abstract

Using a large sample of business groups from more than one hundred countries around the world, we show that group information matters for parent and subsidiary default prediction. Group firms may support each other when in financial distress. Potential group support represents an off-balance sheet asset for the receiving firm and an off-balance sheet liability for the firm offering support. We find that subsidiary information improves parent default prediction over and above group-level consolidated information possibly because intra-group exposures are netted out upon consolidation. Moreover, we document that the improvements in parent default prediction are decreasing in the extent of parent-country financial reporting transparency which suggests that within-group information matters most when consolidated financial statements are expected to be of lower quality. We also show that parent and other group-firms’ default risk exhibits predictive power for subsidiary default. Lastly, we find that within-group information explains cross-sectional variation in CDS spreads. Taken together, our findings contribute to prior literature on default prediction and have direct relevance to investors, credit-rating agencies and accounting regulators.

Keywords: Default prediction, Business groups, Consolidation, Financial reporting transparency, Credit spreads

JEL Classification: G12, G14, G15, G33, M41